Alright so big [inaudible] my name is Earl Lido.
I actually took this class in 2004, I guess the predecessor to this class.
I think, there were like five people in the class.
So, it's great to see that it's grown over time, It's really a pleasure to come back
here every year and talk to you guys, I actually worked in finance before this,
and spoke about what I did then. And then, have since moved on to online
advertising. So there are a lot of cool problems, in
online advertising. And today, I just wanna back up and sort
of tell you guys the, the story of how all this evolved.
It's really easy to look at, you know, a textbook and see a, a really elegant
theory that's been laid down. But, but the truth is most of this most of
how online advertising came to use auctions was actually very organic.
Sort of evolved naturally over time So I think to understand it you really have to
flash back to 1994. I realized for the first time that many of
you in this class may not actually remember 1994.
But as hard as it is to believe, in 1994 people really didn't know what the
internet was. It was just starting to enter the public
consciousness. When people thought of online, they really
thought of America Online. Like you'd sign on, you'd check your
email. There are chat rooms.
It was really cool back in the day. And people were just starting to hear
about, about the world wide web. Companies were just starting to build
websites. And most importantly, 1984 was the year
that online advertising was invented. So this was the first online ad ever
shown, actually. It was probably the most deceptive ad ever
shown. It literally says, I can't read it.
Have you ever clicked your mouse here? [laugh].
And it was it was an AT&T ad, as hard as it is to believe.
And it did pretty well. Like, like, most people had no idea what
this was. Seven out of ten people clicked on it.
Which, by today's standards, is really, really good.
It's, you're really lucky today if you get one out of every 1,000 people to click on
an ad. So this is a very successful ad.
And this really was the birth of a new industry.
It's now, you know. $40 billion a year industry.
It's hard to believe. Back, back then in early 90's, You know, how you got an ad on
a website was a very simplistic model. You literally picked up a telephone and
you called up the website, or sales team at a website, and you said, I want to put
my ad here. And you haggle a little bit over price and
you basically arrive at some CPM, a cost per thousand impression value, that you're
going to pay. And your ad would go up for a certain
amount of time. There wasn't a lot of sophistication to
it. You know It'll be really interesting to
see the equations for this because, this is very simple just haggle over price and
decide. So not much actually changed until sort of
late 90s. I think this was the first revolution in
online advertising. This was the year that Britney Spears
became famous. I don't know if you guys remember that.
Do you guys remember. Like Britney Spears came out with, Baby
One More Time? It was also the height of the dot.com
bubble. Pets.com somehow raised 83 million dollars
without a business model. It was amazing.
And it was also the year that, Idea Lab, which was, like, the Y combinator of its
day launched a company called goto.com. Here's the homepage of goto.com.
It actually looks pretty similar, you know, despite the ugly logo here.
It looks pretty similar to Google and their, their model there business model is
actually very similar as well. They set out to disrupt the, the
classifieds industry. So their, their business model was that
they built a search engine. Actually, they licensed a search
technology from Intomi, that allowed people to search for whatever they were
looking for. And they'd allow advertisers to pay to
have their advertisements actually interspersed with the actual search
results. It'd be like, you know, getting Google
search except the ad, you can't tell what's an ad, and what's an actual search
result. And this model actually took off.
Like, for a while people didn't really know whether GoTo would be the big search
engine of the future or Google. So it's actually a fairly successful
business, and here's how they sold their ad spots.
So they, they built a self service platform, and advertisers could log in,
and they could put in a bid value, an amount that they were willing to pay per
click. And whoever bid the highest per click got
placed up higher in the search results. Now, I think somebody over here asked a
really good question about why that actually matters.
Like, why is it better to be placed up higher?
Look here it matters a lot you know, if you're, cause people are generally assumes
unconsciously that whatever comes up first is more relevant, most relevant search
result. So, you couldn't tell what was a search
result and what was mad. Then whoever was at the very top got all
the clicks. But their model was very simplistic.
It was not a second price option. Whoever bid the highest per click got
highest in the search results. This had some serious issues with it.
So the biggest issue was that buyers figured out that they could game the
system. So they log in, and people figure out what
actually happens if I lower my bid, Could I get the same placement?
And you know, the top buyer actually values you know, a click at $five.
In this case, they can actually shave their bid, they can lower their bid to
$four and a penny, and they can still get the top spot.
So what happened was, literally, buyers would log in and they would change their
bid thousands of times per day. This wreaked havoc on GoTo's
infrastructure. It was very, very, like, difficult for
them to maintain this auction system. And as a result, they also may have lost
money. Over time everybody stayed at their bid,
there's a lot of variation in that, but over time prices were actually lower than
on Google, which we'll talk about. So, fast forward to 2000, 2001.
So, a new company came along called Google.
Which, you know I see a Google shirt over here.
Okay. So, I guess people have heard of it.
And, I think it was actually 2001 that they launched their self serve AdWords
products. And this really changed everything.
You're not only did Google have the best search engine out there, but they really
innovated the way that ad space was sold. So they had two major innovations and both
of these were completely organic. They,
They weren't based on theory. Nobody read a textbook.
According to In The Plex, like the book about Google was actually just the
engineer working on this had these two absolutely brilliant ideas.
So first was he implemented the option as second price option, generalize second
price option. And as you guys know, what this means is
whoever bids highest actually pays what the second highest bidder bid.
So in this case if the top. Buyer.
If the top bidder bids $five per click. And the second highest bidder bids $three
per click, then the top bidder wins the top spot, but only pays $three.
So this incentivizes, by, incentivizes advertisers to actually bid their fair
value. So, in this case, if the top bidder bids
$four they are still going to pay $three, if they bid at $five, they still pay
$three. So they might as well bid their fair
value. You don't see the same effect of what
happened at goto.com where everybody would play around with their bids constantly and
eventually it resulted in much lower bids. The second major innovation which actually
seems very simple in retrospect. It's hard to believe that nobody else
think about this. Was it google tied valuation to click
through rate. What this means is that they, you know of
course you don't realized that just because somebody bids more per click
doesn't necessarily mean that Google is going to make more revenue or effectively
more profit off of that. So if the top bidder here is willing to
pay $five per click. And the second guy is willing to pay
$three per click. But the top buyer get, top bidder gets one
click every hour and the second bidder gets two clicks every hour.
Google's going to make $six by putting the, the second highest bidder's bid up
top. First it was $five.
So this results in a very different ranking of, of how, how ads are actually
shown on a page. And as a result, it maximizes revenue for
the seller you know Google made a lot more money this way.
It's actually kind of shocking to believe. So goto.com was later renamed as Overture,
and sold to Yahoo for about $two billion. And Yahoo, for as long as they were
running their own search engine, actually used a first, basically a first price
auction model and didn't factor in actual click through rate into their, to their
evaluation. So a lot has been, a lot academic research
has been done on Google's auction model and people have, you know, rightfully
discovered that it has a few inefficiencies net.
So one of the, the biggest things and, by the way, it's worth noting that Google
doesn't actually use a pure generalized second price auction anymore.
There's a lot more that goes into it. So this is a bit of an over
simplification. One of the, the big issues with
generalized second price auctions in general is what happens if a bidder values
two of the same goods or two ad spots, in this case, at effectively the same value.
So, what if I'm a bidder and I realize that I get about the same click through
rate. If I'm in the first placement or the
second placement. So in this case I got one click every 60 minutes, if I'm not at
the very top and they get about the same one click every 61 minutes if I'm in the
second highest position. So in this case, if, if I value a click at
$five and the second highest bidder values a click at $3.00, why would I pay $five to
get a click? Why wouldn't I pay2.99 $2.99 just below
the second bidder? In that case I'm going to pay a heck of a
lot less for something that's worth just about the same amount as me.
Because as an advertiser I really care about how often people are clicking on my
ads. So this creates an issue.
There's a lot of, you know, research into how to actually solve this problem.
But, as you just learned Victory Clarke Groves or VCG is sort of the economically
right way to solve this. I'm not going to go into a lot of depth
about it. It actually gets kind of complicated.
And the basic idea is this. So we have two bidders and we're
auctioning off, essentially, two goods. So this is why I'm not in academia.
I think in terms of apples and oranges, [laugh] not equations.
But, but here is a very simple example. We have an apple and orange.
We're auctioning off both the apple and the orange.
We have two bidders. So bidder A says, I'll pay $ten for the
apple but $nine for the orange. I've valued them, you know, roughly the
same. Bidder B says I'll pay $nine for the apple
and $eight for the orange. So in this case, you know, bidder A could
just. Like bid $seven.
Get roughly equivalent value for, for the orange but here's how to solve the
problem. So in Victory Clarke Groves, VCG the
bidder actually pay, the winning bidder actually pays the amount of harm they
cause to the second highest bidder. So in this case, if bidder A wins the
apple, say bid $ten they value at $ten they effectively cause a dollar of harm to
the second bidder. The second bidder now has to live with
this orange. They're are willing to value the apple.
They, they would value the apple at $nine. So they are effectively living with a $one
less of value that they could've had. So by, by charging bidder A just $one.
There's no incentive for, for bidder A to actually bid less purposely to get a worse
bid, but get something that is roughly equivalent in value.
So again this, this actually gets kind of complicated.
Won't go into it much. In practice it's worth noting that not too
many people actually use VCG. The reason being is that sellers actually
make less money and it's also very difficult to explain to buyers.
Especially if you're running a self-service ad platform explaining
something like VCG, which is very complicated, is just too difficult.
So Google makes more money by not using VCG and it's easier to explain to buyers.
It's also more computationally difficult to, to implement.
